FP: RRSPs still have at least 3 advantages over TFSAs

My latest Financial Post column has just been published. It being the height of RRSP season, it looks at some well-known and some less well-known advantages RRSPs still have over the new kid on the block: TFSAs. Click on the highlighted text for the full story online: Three reasons why RRSPs still matter — and one of them you probably didn’t know. The article is also in Wednesday’s print edition on page FP6 under the headline RRSPs still matter despite rise of TFSAs.

The Tax-free Savings Account (TFSA), which was introduced just over ten years ago, is often described as the “mirror imaqe” of the RRSP. That is, the RRSP provides an upfront tax deduction by lowering your taxable income for the year you make the contribution. The TFSA does not, which can be a strike against it in some eyes; on the other hand, once you reach retirement, the TFSA comes into its own by NOT being taxable, and therefore not resulting in clawbacks of Old Age Security (OAS) benefits or (for very low-income seniors) the Guaranteed Income Supplement (GIS) to the OAS.

On the other hand, as many seniors are discovering to their chagrin, all those RRSP tax savings you enjoyed during your (hopefully) high-income earning years come back to haunt you: once the RRSP becomes a Registered Retirement Income Fund (RRIF) at the end of the year you turn 71 (the alternative is the unpalatable act of cashing it all out and being taxed then and there, or annuitizing), then you’ll be on the hook for forced annual — and taxable — RRIF withdrawals. Ottawa giveth and Ottawa taketh away.

But, as the FP piece argues, some decades can elapse between an RRSP contribution and the ultimate RRIF withdrawals, and when you add in the ongoing tax sheltering of an RRSP — on top of the upfront tax contribution — then the experts quoted in the piece believe the RRSP comes out, certainly if you’re at or near the top tax brackets.

Below is the arithmetic provided by Mathew Ardrey, wealth adviser at TriDelta Financial, which was too long to include in the FP version. He cites the example of someone who has $10,000 of income and can invest in either a TFSA or a RRSP:

“The part of the example I would focus on, is what is a reality for many Canadians, their income is higher while they are working than in retirement. Because of this, there is a clear advantage of receiving the deduction at a higher marginal tax rate and paying tax in retirement at a lower marginal tax rate,” Ardrey concludes.

Foreign income taxed less harshly in RRSPs than TFSAs

But that’s not all! As the FP column mentions, there are at least two other advantages RRSPs have over TFSAs. One is that foreign income is taxed more in TFSAs than in RRSPs: because the US and other foreign jurisdictions don’t consider the TFSA a bona fide tax shelter like the RRSP, US or foreign dividends or interest income will be subject to a 15% withholding tax that is not imposed on the same investments housed in an RRSP.

RRSPs help save for higher education or down payment on a home

Finally, there are at least two other advantages RRSPs have: despite its name they’re not just for retirement: they can also help you go on to higher education or  save up a down payment for a first home: you can withdraw up to $20,000 for the Lifelong Learning Plan, and up to $25,000 for the Home Buyer’s Plan ($50,000 for couples). You do however have to repay at some point.

In the end, the RRSP versus TFSA question is not an either/or zero-sum game dilemma. As financial planner Aaron Hector argues in the FP column, young people in lower tax brackets are probably better off starting with a TFSA. They can later move that money into an RRSP once they’re in high enough tax brackets that it would be worth while to lower their taxable income.

As for those already in higher tax brackets, then by definition they can afford BOTH to make RRSP contributions to lower their taxes AND to contribute the maximum $6,000 each year to a TFSA. They can have the best of all worlds!